onion to determine executive compensation. Going Beyond Benchmarking. Especially as CEO pay remains a front-page news it
Vol. 2, Issue 2, 2015
Risk Issue
Taking on Risk Smarter boardrooms turn new challenges into potential rewards
Considering the universal ballot Safeguarding against cyber attacks
What will be the biggest risk facing boards in 2016? Overcoming risk on critical projects
Interviews with Sabastian Niles and Suzanne Vautrinot
24
PAY GRADE
evaluating CEO pay metrics
Examining New
Perspectives Why companies should go beyond benchmarking when evaluating CEO pay By Irv Becker H AY G R O U P
F
aced with increasingly active
continue to blame benchmarking for ratcheting up
investors and a tense shareholder
pay to higher levels and decoupling compensation
environment, boards are under
from CEO and organizational performance.
more pressure than ever before
Shareholders’ and investors’ focus on capital
to make informed and business
returns, desire for top-line growth and pressure on
case-driven CEO pay decisions
profits are forcing boards to reconsider not only
that are seen as “fair” by an
what they pay CEOs, but also how they structure that
expanding pool of stakeholders—from investors
compensation. At the end of the day, while bench-
and employees to the CEO and the general public.
marking has its place, it is important for boards to
While peer-group benchmarking is still the most
common tool for determining CEO pay, this approach has faced increased scrutiny from critics, serving as a catalyst for risk for boards across industries. The critical eye on CEO pay is an outcome of the
think more broadly and peel back more layers of the onion to determine executive compensation.
Going Beyond Benchmarking Especially as CEO pay remains a front-page news
financial crisis, which exposed the shortcomings of
item, boards must use multiple lenses to evaluate
the benchmarking process and simultaneously put
compensation via a more complex and rigorous
pressure on organizations to find new and better
assessment of both internal and external factors.
ways to reward their top executives. Today, critics
This will create the context for decision making that
25 goes beyond the numbers and cre-
compensation against the company’s overall strategy and objectives, consider-
ates a business case for CEO pay.
ing external factors, including: • CEO role, responsibilities & complexities. Determining the goals the board has
Externally, this process considers the relative scope,
for the CEO role and how it will measure and reward that person for achieving
complexities, challenges and
those milestones is important. Factoring in any challenges associated with the
expectations of the chief execu-
role and evaluating the differences and expectations of the CEO’s role relative to
tive role. Looking inward, boards must examine the culture, leadership style, pay differentials between CEO and direct reports, and how well the internal talent pool has been developed for a successor. In evaluating each criterion, boards must ask themselves, “What do we want to achieve as a business?,” “What are the unique expectations of the CEO’s role?,”
Irv Becker is the U.S. Leader of Board Solutions at Hay Group. He is based in the New York City area and can be reached at Irv.Becker@ haygroup. com or (302) 379-8885.
“How will the way we compensate our CEO support those goals?” and finally, “How will we measure the return on our investment?” The end goal is to establish “internal equity,” or
the market—such as needing to turn around a struggling business—is also key. Ultimately, mapping these answers against the CEO job requirements and expectations will, in turn, foster a holistic view of pay that is both “fair” and effective. • CEO expectations. The CEO needs to perceive the compensation that the board is offering as being of equal value to a pay package with a different structure elsewhere. The chief executive should also understand what needs to happen in order for the incentives of the package to pay out. To glean a more complete picture, boards must also look inward to evaluate CEO pay, examining the following criteria: • The CEO as an individual. Taking a close look at the CEO’s experience, skill set, leadership style, motivators and appetite for risk is critical. Boards must determine whether the chief executive will thrive on a low-base salary, with high potential pay-outs from incentives, or whether a more balanced pay program would be more compelling. • Corporate culture. What the board pays the CEO sets the tone for the culture
the perception that the organization is paying
of the organization, so it’s important that his or her pay reflects the compa-
people according to the relative size and the impact
ny’s overall compensation philosophy and corporate culture. Comparing pay
of their roles on the organization. This will diminish
levels between the CEO and his or her direct reports can reveal important
the risk associated with CEO pay by leading boards
perspectives on internal equity and help the board ensure that the people
to create an executive compensation program that
at the layer below feel appropriately rewarded for their work.
balances fairness and competitiveness with the
• Succession planning. Determining whether there are CEO successors stand-
responsibilities and complexities of the chief execu-
ing in the wings will inevitably impact CEO pay. Internal candidates will
tive role.
generally not require a marketplace premium to assume the role for which they have been groomed, whereas recruiting from the outside often requires
Building the Business Case
a premium in addition to award buyouts, while also incurring the associated
Fairness is the current buzzword in executive
risks of bringing in an outside executive to run the organization.
compensation—and understandably so. As CEO pay transparency is required and the pay ratio disclosure
The Result? Reduced Risk
is looming for all public companies, the compensa-
The pending implementation of the CEO pay ratio disclosure, looming deci-
tion conundrum has spread beyond the boardroom and into mainstream conversation. This has resulted in an ever-expanding pool of people who have an opinion on how fair (or not) CEO pay is at an organization. Boards must take all of these often competing views
“
sions on pay for performance disclosures, and constant debate surrounding pay and
As CEO pay remains a front-page news item, boards must use multiple lenses to evaluate compensation.”
seriously when making pay decisions. To establish internal equity and determine the most effective level of CEO pay, boards must weigh
income inequality ensure that CEO pay will stay at the forefront of discussions in the media and politics, as well as among shareholders and active investors. As a result, using multiple perspectives to evaluate CEO pay, rather than solely relying on benchmarking, will help to protect boards and create a solid foundation for accurate and effective CEO pay decisions. Ultimately, CEO pay analysis doesn’t stop when compensation has been determined. For maximum effectiveness, boards must
continue watching how changes in viewpoints and the business environment affect the business case for pay and tailor CEO compensation accordingly.
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we believe that creating alignment between the board and ceo is the key to driving performance.
Treating CEO succession, performance evaluation and compensation as separate activities leaves board members, stakeholders and the organization vulnerable to significant risk. By integrating these processes, you create stronger linkages among critical elements of the CEO life cycle and improve organizational performance. To find out how we can help you with the CEO life cycle visit www.haygroup.com/us
